My Theory on The Price of Bitcoins and Cryptocoins

One of the things I notice is that there are so many positive spin websites and postings out there about bitcoins and cryptocoins. It’s like there is an entire industry of people who’s only job is to create the illusion that the price of coins is somehow going to go up because of this positive sign or that positive sign. Some of it, frankly, borders on being the pump side of a pump and dump scheme, and there are plenty of stories out there suggesting that many of the price fluctuation are in fact market manipulators at work. It’s not hard to see how this can happen.

I will work on the basis of Bitcoin here, but my opinion (and it’s only my opinion) applies to pretty much all coins. While the Bitcoin price in USD did run up to near $20,000 (and I celebrated bitcoin $20,000 a little bit prematurely), it has sunk back down to it’s very narrow current trading range of $6200 to about $7000, and most of that range is actually $6200-$6500. I have a theory about this, and it’s pretty simple:

We are down to replacement cost.

It costs realistically average about $5000 usd today to mine 1 bitcoin, all in and all considered. Some places with cheaper electricity might get off a little cheaper than that, but not much. So for every $5000 you spend, you get a coin worth about $6200 in the current market. That is profitable. However, the difficulty keeps going up, the returns gets smaller, and there is a continued squeeze. There is a “halving” of the rewards that should hit around May 2020, so people buying equipment to mine now need to recoup all that they can before that point, otherwise their returns will be literally half! That’s a whole other story I will talk about at some point in the future.

Now, for the moment, if you spend $5000 to make $6200, you are getting off pretty good, 20% plus margin in theory. But, and this is key, if everyone who mined Bitcoin immediately turned around and sold it, the market would be driven down to the point where it wouldn’t be profitable to sell. My theory is that for most mining operations, $6200 is actually pretty close to their TRUE cost of mining, when you consider manpower, time, rent, facilities, and the like. The $5000 number is straight machine plus electricity, but you need to have people to maintain the equipment, you need to have a place to put the equipment, and of course, you have to pay to fix it when it breaks. So these people are unlikely to want to put their coins on the market for the current price.

On the other side, and this is equally weird, these miners also seem to have little interest in buying coins at this price point. If they could get coins cheaper than what it costs to mine them, you know they would buy rather than mine. That is what I think has happened when the price has dropped below $6000 at the end of June, people purchased based on the simple belief that the price was below replacement cost.

What it points to for me is that there isn’t as much outside money in the game. The run-up of the price of bitcoin was related to outside buyers coming in and paying a premium to own bitcoins. The price far exceeded the replacement cost, so it was profitable and reasonable to mine all you can. Now there is no longer a big premium, and seemingly few people willing to inject money into buying Bitcoins at anything other than replacement cost. There is little to make that change. Without a significant outside force, the price will no increase again, and those inside the system already mining are not going to short their own product in the market, so there is little there to push the price down. It’s in many ways the HODL concept in practical application.

The real driver is that many, many of the biggest mining pools are investment committed to mine for the foreseeable future. They have built their mining operations and need to keep them running to earn enough to pay for all the equipment, it’s amortization, and it’s depreciation. Many people (like myself) who were mining on less sophisticated equipment or on expensive contracts are underwater from mining. Large pools are no different in reality, they do have a lower break even point, but increased difficulty and lower rewards per Th/s means that they too are fighting a losing battle. They are fighting against the halving clock as well, and against a market that appears to have fewer and fewer dollars coming into it.